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Jokowi's call for rates to "fall, fall, fall" raises Indonesia risks

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President Joko Widodo has urged the authority to keep reducing borrowing costs and has ordered banks to cap deposit rates as he seeks to revive economic growth from a six-year low.

[JAKARTA] With Bank Indonesia seen cutting interest rates for a third month on Thursday, some economists say the president's call for rates to "fall, fall, fall," is making the nation more exposed to any emerging-market selloff.

Fifteen of 24 analysts surveyed by Bloomberg see the policy rate being reduced 25 basis points to 6.75 per cent, with the rest forecasting no change. The cuts have lured almost US$3 billion of inflows to Indonesian local-currency sovereign notes this year, making them the best performers among Asian emerging markets.

President Joko Widodo has urged the authority to keep reducing borrowing costs and has ordered banks to cap deposit rates as he seeks to revive economic growth from a six-year low.

Cutting rates too fast raises the risk of capital outflows in the event of a global shock and may increase soured credit just as the government budget faces strains, according to Natixis Asia Ltd.

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"This is a negative development for the country," said Trinh Nguyen, a senior economist at Natixis in Hong Kong.

"Investors will gloss this over as long as risk appetite remains strong, but we know this also changes very quickly."

There's room for one more 25-basis-point cut, said Trinh. Of 26 economists surveyed by Bloomberg, eight see a policy rate of 7 per cent by the end of year, 10 forecast 6.75 per cent, seven predict 6.5 per cent and one projects 6.25 per cent.

Jokowi said in an interview last month that he wanted the benchmark rate to "fall, fall, fall, fall and keep falling." The Financial Services Authority, or OJK, said Feb 29 it would lower the ceiling for deposit rates at seven large banks to 75 to 100 basis points above the central bank reference rate.

"Indonesia can argue that it has a window of opportunity to cut rates, especially in the context of the commodity bust requiring policy easing," said Vishnu Varathan, a senior economist at Mizuho Bank Ltd in Singapore.

"With incremental rate cuts, and other efforts to boost money supply, latent inflationary risks do build, and this will in turn undermine macro-stability if the productivity pickup does not keep pace over time."

Indonesian local-currency sovereign debt has returned 14 per cent over the last six months and the rupiah has surged 10 per cent.

The exchange rate remains vulnerable and the government needs to focus on state revenue reform to widen the tax base, not just on boosting fiscal spending, which is unsustainable, Anton Gunawan, the chief economist at PT Bank Mandiri, told reporters in Jakarta on Wednesday.

Southeast Asia's largest economy grew 4.79 per cent last year, the least since 2009, as the prices of Indonesia's major exports such as coal and palm oil declined.

The government is targeting expansion of 5.3 per cent this year.

The 2016 budget calls for both higher revenue and stimulus spending, even after tax collection fell around 20 per cent short of target last year. Anticipating a funding crunch, Finance Minister Bambang Brodjonegoro has said he plans to cut routine public spending and is hoping the parliament will pass a tax amnesty that could bring in extra revenue. Lawmakers postponed deliberating the bill this month.

"The balance between increasing tax collection and borrowing is going to be the essence of public policy making and macro management over the next year," Rodrigo Chaves, the World Bank's country director in Indonesia, told reporters in Jakarta on Tuesday.

"Increasing revenue is imperative, whether it's difficult or easy it has to be done."

Indonesia's 10-year sovereign bonds yield 7.74 per cent, the highest among Asia's emerging markets and 5.84 per centage points more than similar-maturity Treasuries.

The rupiah has been driven by bond flows amid the prospect of rate cuts, said Gundy Cahyadi, an economist at DBS Group Holdings Ltd in Singapore.

"The most important thing has been the yield differential between Indonesian assets and the Group of Seven economies," he said.

Consumer-price gains have stayed below 5 per cent over the last four months after exceeding 7 per cent in the middle of last year. The bond rally should continue and HSBC Holdings Plc is recommending clients be long on 10-year notes, said Pin Ru Tan, a rates strategist at the lender in Singapore.

"The authorities need to be watchful of triggering inflation pressure as loan growth and inflation share some degree of correlation," she said.

"The government, the OJK and Bank Indonesia must therefore jointly ensure that they do not loosen monetary conditions too rapidly or excessively."

BLOOMBERG

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